Do the homework on real estate funds

MUMBAI: If you have more than a few lakhs waiting to be parked somewhere, investing in real estate must have crossed your horizon. Real estate investments, a high-end one and typically meant for wealthy individuals, have been delivering internal rates of returns of around 18-25 per cent per annum in the past few years.

Such high returns has been drawing many new investors to real estate investment funds that typically operate through the private placement route with wealthy individuals. Wealth management firms often cater to their clients' real estate diversification requirements through these funds, rather than a direct exposure to real estate. The total investment made by real estate funds in the domestic market since 2008 amounts to Rs 14,705 crore, according to data from Cushman and Wakefield.

As with all investment vehicles, if you are not careful in selecting the right one, chances are you could lose your sleep. In an order dated October 31, the Securities and Exchange Board of India (Sebi) barred Servehit Housing and Infrastructure from mobilising money from the public. The firm had offered a scheme to purchase, develop and maintain plots. Sebi noted, "Prima facie, it appears Servehit Housing and Infra is running a CIS (collective investment scheme) without obtaining a certificate of registration from Sebi as required under the... CIS regulations."

BEHIND REAL ESTATE DEALS

The structure: Promoted by Indian investment firms and registered with Sebi, these funds invest in commercial property, residential property, developed or under-developed for capital appreciation

The costs: Fund management fees usually range between 1-3 per cent and additional fees might kick in if the fund does well and delivers excess returns over a pre-determined limit

The benefits: Investors can get exposure to multiple projects under-development in different geographies and professional expertise to manage funds on their behalf

Back ground and track record: Funds should have domain expertise in different areas such as commercial or real estate and an existing performance track record, especially of timely exits from projects.

Issues such as these raise a red flag. Besides, this market behaves differently across regions, so investors also need to know the investment strategy a real estate fund manager will follow. For example, prices are high in Mumbai but unsold inventory is also rising, while in Hyderabad, there's a property glut.

Says Amit Bhagat, CEO and managing director, ASK Property Investment Advisors: "Gone are the days when everybody will make money in real estate. One has to partner with the right developers and also be careful about the entry price in real estate projects." The returns on real estate funds not only depend on the real estate market, but also on the projects the fund has invested. Given the lower liquidity, higher lock-in investors should normally expect a higher return of around 18-20 per cent from such funds. Such funds also have a fund management fee which is normally around two per cent. Besides, these funds can also charge additional fees if the profits exceed a pre-determined hurdle rate. Experts say that net of all fees investors should get around 14-18 per cent for the risk taken in real estate investments.

So, a key question for investors is where and how should one go about investing in real estate funds. Who is promoting and managing such a fund? By adding these funds to your portfolio, are you obtaining the diversification you seek? What are the varieties of real estate funds you should look at?

Check the foundation: A thorough background check of the promoters of a real estate fund and its management is a requisite. Funds registered with Sebi have to adhere to certain minimum conditions such as proper managerial staff and trustees to oversee the investment and compliance issues. Sebi-registered funds also have to furnish their investment schedule and the targeted amount to be raised.

Real estate funds also have to file with Sebi an exhaustive private placement memorandum underlying all aspects of the fund management process, and so on. Promoters have to bring in a minimum of 2.5 or five per cent of the corpus, depending on size and category of fund.

Till May last year, real estate funds were mopping money from investors, typically wealthy individual owners or private trusts and funds through the venture capital (VC) fund regulations of Sebi. These regulations were aimed at funds that were garnered privately through the VC route. The minimum investment here is Rs 10 lakh but most funds were accepting minimum deposits of around Rs 25 lakh.

However, in May 2012, Sebi notified new AIF (Alternative Investment Fund) Regulations for private equity, hedge funds and real estate funds, among others. The norms say funds should not have more than 1,000 investors and the minimum investment amount should not be less than Rs 1 crore. Realty fund managers say these new regulations have been designed to protect small investors from venturing into high-risk investments such as real estate or private equity.

Says Lalit Kant, head real estate, Arthveda, an investment management firm of DHFL: "All the new real estate funds being launched have to be registered under the AIF guidelines, which means only really big investors can participate. This will deter small investors from venturing into such high-risk assets."

Construct your portfolio: Private real estate funds invest in a variety of property or under-developed projects, usually paying out all their profits as capital gains when the fund exits from a development project. While holders of real estate shares can expect dividends or a gain in share prices, real estate fund investors are usually looking for an upward spike in prices and participating in profits through appreciation. Investors should also scrutinise the investment profile of a fund and the kind of properties it is likely to invest in.

Says Sanjay Dutt, executive managing director, Cushman & Wakefield: "How a fund invests boils down to the actual team of the fund manager and the composition of the investment committee. One should ask basic questions such as: What is the vision of the fund? Is it an income fund or a capital appreciation one? Will it invest in residential or commercial property and in which geographies? It will give a direction to the fund."

Back the track record: One crucial factor to consider before investing in a real estate fund is its exit strategy from projects. After all, investors have to get their monies back, with a reasonable profit. Fund managers should explain to investors the kind of properties they are likely to invest in and whether necessary permissions have been taken. Look at the costs of projects and expected future revenues when a project is completed to get a sense of the profits one can expect to make now. Says Dutt: "It's the quality of past projects a fund has built which should drive an investor's interest in it - and how much such projects have delivered to investors."

Finally, examine the record of past funds from the same promoter and the returns to investors. Check if the past funds made successful exits from projects and returned money to investors. Says Kant: "To build a track record in real estate investment takes a long time but it also gives a fair idea if future investments are in good hands." Returns from real estate investment funds are all about time. If a project is delayed, returns can fall substantially.

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